As DAFs grow in popularity, it is important to consider their various benefits and to understand how they work.
For a variety of reasons, donor-advised funds (“DAF”s), which have been in existence since before World War II, have gained popularity in recent years. They have become a useful and attractive tool for both charitable giving and tax control.
DAFs have many benefits, from anonymity to estate planning. It is important to understand how they work and then consider their benefits and whether they are right for you.
HOW DO DAFS WORK?
Every DAF has a sponsoring organization that manages it. There are many, and they range from large financial institutions such as Fidelity and Schwab to more narrowly focused entities such as The Signatry, DonorsTrust, Bradley Impact Fund, or the Jewish Communal Fund.
These sponsoring organizations create a nonprofit entity, generally maintained and operated under section 501(c)(3) of the IRS tax code. As a result, when you make a deposit into a DAF, you are making an immediate donation to a tax-deductible charitable entity.
When you create a DAF at one of these sponsoring organizations, you get to name the fund (e.g., “The Our Family Giving Fund”), and you can deposit money when it is most convenient for you. Any time you make a deposit, it becomes a charitable donation for that year.
Like other investment accounts, you will get statements and can have online access to see how your DAF account is doing. However, once the money is deposited into the DAF, it is technically and legally no longer yours. You have given up legal control over the property.
You are still allowed to manage the investment strategy within the account, typically, by choosing from a variety of mutual funds. Since this is a donor advised fund, you are advising and not directing the investments, but the sponsoring organization is not likely to disturb your advice.
The other advice you get to give is which charities ultimately get the money, how much, and when. For example, if you deposit $20,000 into your DAF, you may decide in July to recommend $2,000 to the local food bank or homeless shelter. The recipient organization must be a 501(c)(3) charity to qualify to receive the gift.
But keep in mind: The sponsoring organization has the ultimate authority to make the gift or not. If you use a DAF at a sponsoring organization that has a narrower focus, your gift may have to go through that sponsoring organization’s filter before the gift is approved (and larger DAFs increasingly have their own implicit or explicit requirements). If the charity you choose to receive a gift from the DAF does not fall within the acceptable charities of the sponsoring organization, the gift can be refused. Make sure you understand whether the DAF you set up is with a sponsoring organization that will support the type of nonprofits you want to support. You should be aware of the sponsoring organization’s standards before setting up a DAF.
The gift you advise comes from the DAF and not you directly. So you will not get another tax deduction when the recipient charity receives the gift as you already received your tax deduction in the year you gave the money to the DAF.
WHAT ARE THE BENEFITS OF A DAF?
There are numerous benefits to using a DAF, here are a few that you might consider before choosing to make use of one.
First, you can obtain some tax control. Of course, you should review any tax strategies with your tax professional. If you are having a year with outsized income because your company got sold, you exercised some stock options, or you received a nice bonus, and you want to get a bigger deduction, it may be worth considering a DAF.
For example, if you normally give $10,000 per year to a particular charity, and you could really use a big deduction this year due to outsized income, give $50,000 to the DAF and claim the full $50,000 deduction in your big income year. In the following year when you anticipate less income, and less need for deductions, make your charitable gifts out of the DAF.
If you generally claim the standard deduction, you can make one big charitable gift in the year you itemize and claim the standard deduction in other years.
You can also potentially avoid paying capital gains taxes if you put assets into the DAF. If you have stock with low basis that you have owned for a year or more, and you don’t want to sell because of the capital gains tax, then gift some of that low-basis stock directly to the DAF. The DAF can sell it immediately upon receipt, but no capital gains tax will be triggered. Also, you will likely be able to take a tax deduction for the full, fair market value of the stock at the time of the gift.
A third benefit of DAFs is that your charitable gifts can be made anonymously. Of course, they don’t need to be, but if you want to make an anonymous gift, a DAF is a great way to do so.
You can also name a successor to make gifts after you pass away or are otherwise unable. This is often a great way to include the next generation and draw them into your pattern of generosity.
Yet another reason to use a DAF is that they are a great way to make an estate gift without having to lock a charity into your will. Most DAF sponsoring organizations will allow you to set up a succession plan whereby the money in the DAF will go to charities you designate ahead of time. Therefore, you need only change your succession plan with the DAF instead of getting your estate planning attorney to update your will every time you change your mind.
Finally, there are some DAF sponsoring organizations that will allow you to let the money in your DAF account to be invested in certain “impact investments.” In this way, not only is your money ultimately benefiting the philanthropic charities you desire to support, it is also helping the beneficiaries of the various impact investments you have chosen to invest with prior to ultimately giving the money to the final charitable beneficiary.
While a DAF is a rather simple structure, it has a lot of flexibility and many benefits and should be considered by any person who pays taxes and has a desire to be generous.